Madoff, MLK, Buddha And Elusive Nature of Self-Interest

A repost of one of my favorite – and one of my most read – posts in honor of Martin Luther King Day. It was originally published December 24, 2008.

Back home after dropping off my friend at the airport. As those of you who have been following me on Twitter know, I’ve spent the last few days visiting with an old friend from my JP Morgan Latin America days. Kenny recently came out of almost five years of semi-reclusive Buddhist retreat. We hadn’t seen each other during that time, but had been in touch each time he was home in Brooklyn for the holidays or between sessions at the retreat in Northern California.

We worked together in Latin America, primarily Brazil, during the Year 2000 project period. I was JPM’s PMO Director for the project in Latin America. He was implementing a new order entry and trade management/compliance system for their equity options and derivatives business. As calm and serene as he has learned to be when faced with crowds, traffic, schedule changes and chatty friends like me, he is also still human. And he is still my old friend with enormous knowledge of how and why controls and regulations are intended to safeguard investors in financial services industry.

It didn’t take much to get him to talk about the Madoff scandal, the financial crisis, the Big 4 firms, the SEC, and the major players on Wall Street. As much as things should have changed in the seven years since he was actively working in the industry, unfortunately according to him, most things have not. He was up to speed, even more than me in some areas, since he has been catching up the last few weeks by subjecting himself to a heavy daily dose of MSNBC, CNBC and BloombergTV.

I sought his advice on some topics and ideas for posts, but he continuously pulled me back to the human element, the psychology of the issues we discussed.

Heady stuff. Fortunately he has not given up drinking or laughing so the heaviness was lightened with caipiroskas, pinot noir, Negra Modelos, and cuba libres.

One of the topics we kept coming back to is the responsibility of “professionals,” those who are licensed and mandated by their states to uphold a code of ethics and professional responsibility that demands action beyond that which does or doesn’t profit one personally. Your first obligation as a professional is to your client, not your firm, your partners, or even your family. If your client is doing something illegal then it is to law enforcement. That may seem harsh, but it’s the code that’s supposed to insure that lawyers and accountants, for example don’t cut corners out of their own self-interest and to the detriment of their client’s interests.

“By accepting membership, a certified public accountant assumes an obligation of self-discipline above and beyond the requirements of laws and regulations.

The Principles call for an unswerving commitment to honorable behavior, even at the sacrifice of personal advantage.

A distinguishing mark of a profession is acceptance of its responsibility to the public. The accounting profession’s public consists of clients, credit grantors, governments, employers, investors, the business and financial community, and others who rely on the objectivity and integrity of certified public accountants to maintain the orderly functioning of commerce. This reliance imposes a public interest responsibility on certified public accountants…In return for the faith that the public reposes in them, members should seek continually to demonstrate their dedication to professional excellence.

Due care requires a member to discharge professional responsibilities with competence and diligence. It imposes the obligation to perform professional services to the best of a member’s ability with concern for the best interest of those for whom the services are performed and consistent with the profession’s responsibility to the public.”

Martin Luther King Jr.: “Morality cannot be legislated, but behavior can be regulated. Judicial decrees may not change the heart, but they can restrain the heartless.”

Regulate the immoral. Restrain the heartless.

It’s hard for an external auditor to step up and do the right thing. As I have written in so many other places in this blog, the model of providing this critical public service meant to protect shareholders (the purpose of the audit report) via a profit making private partnership often encourages “behavior that must be regulated” (as the PCAOB was charged to do after Sarbanes-Oxley.)

Many, even the young professionals writing me in earnest for advice, have either never learned or have suppressed the nature of the true auditor-client relationship. The client for audited financial statements is the shareholder, not the company management. The Audit Committee of the Board of Directors, who hires and is supposed to manage the external auditor, represents that shareholder client. Other beneficiaries include bondholders, lenders, employees, vendors/customers who depend on the continued viability of the company, and regulators (whose role is to protect investors and overall capitalist system.)

When they forget or suppress acknowledgement of the true client, an auditor loses the ability to properly structure decisions with moral and ethical implications, let alone those with serious legal and regulatory ones. In the face of potential legal implications of a decision, they seek advice from their own counsel in order to avoid liability. In the face of a moral or ethical dilemma, they look at costs/benefits of looking out for the shareholder versus looking out for their own financial self-interest, at an individual and at a firm level.

Man naturally desires, not only to be loved, but to be lovely; or to be that thing which is the natural and proper object of love. He naturally dreads, not only to be hated, but to be hateful; or to be that thing which is the natural and proper object of hatred. He desires, not only praise, but praiseworthiness; or to be that thing which, though it should be praised by nobody, is, however, the natural and proper object of praise. He dreads, not only blame, but blame-worthiness; or to be that thing which, though it should be blamed by nobody, is, however, the natural and proper object of blame.

“He’s a man of integrity. He lives this company. He is a pillar of the community. He donates to charity. He is an elder statesman of the industry. He has unquestionable, unassailable ethics and cares about this company.”

And maybe they are also told, “How dare you suggest that he would ever do anything to harm his employees, shareholders, business partners…”

Faced with the challenge of questioning someone who everyone else thinks is an icon and may not be, most people back down, question themselves, wonder if they’ve read, seen, or heard what they thought they had. Pressured by the cost of moving forward with potentially imperfect evidence, or with an accusation that shakes the foundations of belief and trust, most “professionals” trust their boss, the lawyers, the advisors, and drop it. Add more pressure over accusations that potentially threaten a lucrative business relationship, a big deal, or an important hire, speaking up is often a career limiting move, threatening your own livelihood.

But auditors, who are inevitably almost always CPAs also, have a higher responsibility. Making the type two error of being right in your suspicions of illegal activity and potentially enormous harm or loss and not acting on them is completely unacceptable. US Attorney Patrick Fitzgerald explained his decision to bring corruption charges against Illinois Governor Blagojevich before all “the t’s were crossed and i’s were dotted” this way:

“…But I was not going to wait until March or April or May to get it all nice and tidy and then bring charges and then say, “By the way, all this bad stuff happened because no one was aware of it back in December.” I think that would be irresponsible. (Cross talk.)

So sometimes, when there’s ongoing criminal conduct — and this is a very different case than what we often see — we will expose the criminal conduct and bring charges to let people know we’re on to it, and to hopefully — to put a stop to it…“

Don’t let anyone ever tell you again, after Madoff and the rest of the cases of hubris we have seen during this ignominious year, that any man or woman is above suspicion. When you’re told, “He’s an icon,” as an auditor you should look even harder, be professionally skeptical, trust your own instincts and judgment as long as they have been educated and are competent and objective. Push hard for truth and justice.

As the guardians, the watchers, those entrusted by the investors with seeing and speaking up when they can not do so themselves, if you don’t do so then history is bound to continue repeating itself.

“So how did these exceptionally smart people forget their habits of due diligence? One answer lies in the curious respect Americans have for their leaders, which is something rarely appreciated in Europe. Anyone who reaches the top of the pile in the United States, whether in the law, broadcasting, investment management, business, the church or sport is given unwavering respect.

Their employees and supporters faithfully cluster round and offer up what seems to the European eye to be blind fealty. Pastor or president, you become the Man, at which point followers begin to suspend all judgment. Madoff was the Man and potential clients had to be damn well connected for him even to consider trousering the $1m minimum investment.

This tradition may have something to do with the small groups of pioneers that struck out West and relied on their leaders for their survival, but I prefer HL Mencken’s insight that while Americans see themselves as rugged individualists, they are rather conformist, as well as respectful. “There are no institutions in America, only fashions,” he once wrote.

It is true that Americans are often “furiously trying to join something, enroll others or keep them out. The more exclusive a country club, society or nightclub the more desperate they are to gain entry…”

Or avoid being kicked out.

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Look at baseball. Bud could have gone ahead and issued his case against Bonds before he broke Hank’s record. The evidence didn’t change. Bud waited until Bonds broke the record. Now baseball has to settle the record. If you have to pull the trigger, pull it.

Pulling the trigger is all well and good, but what if you can’t convince everyone beyond a shadow of a doubt? What if you don’t win? What if you have a family and you’re ruined? How do you make that decision?

I understand the code of ethics, but I also understand the code of your family. And I’m very happy to not be a CPA as a result.

Terrific post! It reminded me of a time from my past. Twenty five years ago I was preparing to sit for the exam for the first time. I had signed up for a preparation course. Not knowing what to expect, I was surprised on the first evening by the fact that our discussion leader was confined to a wheelchair. Turned out that he was special, but in ways that I would never have imagined. His intelligence, wit and enthusiasm elevated his sessions way beyond anything I had experienced during my college years even though those classes were always led by teachers with no such physical limitations. I believe that he fully expected to be able to teach us, not only every financial reporting rule that was in existence at the time, but that we should be fully capable of understanding the exceptions to each rule along with their appropriate applications.

Mostly, what I remember about him was his ability to read the class. He could sense our demeanor as we staggered to our seats after a long day. Even on the dreariest of nights, during the middle of tax season, he could come up with just the right anecdote to pump up our spirits and get us back on track. The proof was that he drove one particular mediocre student to success, instilling confidence and sense of purpose along the way, by showing him how to pass all four parts of the exam with flying colors on the first try.

I have no doubt that your writing is having the same effect on many of the young people who follow your blog. We need people like you to continue to not only clarify what this profession is truly about, but also to inspire and instill confidence in young folks to do what is right.

BTW, it’s pretty ironic to someone who came of age when macho command and control types were worshiped above all else, that it has been women like you, Yves Smith and Tanta over at CR, who’ve been true role models of leadership during the current crisis.

Francine:I have a couple of posts about the Aguirre scandal. I have many, many posts about the SEC and DOJ revolving doors. As for being a whistle-blower, I strongly suggest against it. The odds you will get anything from your effort aside from a ruined career are less than one in a thousand. Really, not one in a thousand. The system is rotten from top to bottom. Look at the recent Siemens scandal for example.

There is something very 19th century about the AICPA Principles of Professional Conduct. In todays’s world, it’s not a lone individual CPA who audits mega-businesses, but the Big-4 mega-firms. Such firms, as opposed to the very moral individuals in them, are (as DeGaulle said of nations) “amoral monsters”.

Bob Daniels:The AICPA rules are a fig leaf. As a practical matter, what will the AICPA do to the Big 87654 which audit 98% of SEC registrants by market cap? Nothing. Who needs the AICPA? Not the public.

Thank you for a true Christmas sermon that speaks to the necessity of living the ideals of Christmas. What you have described is not just relevent to large corporate structures but also local governmental units. Years ago I worked for a metropolitan county in Minnesota and saw the same relationship between the outside auditors and the governmental unit. How do you create change when something is so institutionalized in our culture at every level? Thank you for the comments on the Aguirres. I now live in San Diego County and have seen the demonization that led to the election loss. We lost a good one!

First, this blog is a great source of information, and a joy to read – kudos to Ms. McKenna for the effort.

I went to accountingmalpractice.com and it warns the site will be de-activated as of June 30, 2009. That just about says it all.

I can speak from a time from about 25 years ago when I first got my CPA license, to now, returning to the profession, after years on the mommy track. While raising my family, I, too, had the chance for spiritual self study in practicing and teaching yoga. It was (and continues) to be an incredible eye-opener. It’s all about seeking the truth, isn’t it? After all, that’s why becoming a CPA was so important to me. It was all about finding the truth and helping others see the light.

I don’t know about the shareholders anymore, they have been replaced by the mutual funds, hedge funds, black boxes and the like. There is no real investment – the only focus is the quick buck.

As someone else posted earlier – the accounting practice model is broken; the whole system is broken. Good Luck to all.

[…] affinity groups – members of the same ethnic group, church, or other close-knit community. No one wants to be left out and people will, at times, compete or beg to give their money to the scamster so they can boast […]

[…] early on, he was partially motivated in his quest to get the SEC to listen to his theories about Madoff’s fraud by the potential for whistleblower rewards. From The Boston Globe in January 2009: Markopolos […]

[…] past summer over insider trading charges related to several Fortune 500 companies. Auditors have a public duty to shareholders and a legal obligation under federal securities laws to maintain engagement confidentiality, in addition to their contractual obligation to do so. […]

[…] past summer over insider trading charges related to several Fortune 500 companies. Auditors have a public duty to shareholders and a legal obligation under federal securities laws to maintain engagement confidentiality, in addition to their contractual obligation to do so. And […]

Some may question the benefits/need of having a Big 4 or nationally known CPA firm standing behind an audit. I understand Madoff’s firm was “audited” by a small local CPA firm. I’m surprised any Madoff investor did not view this as a RED FLAG. I was once auditing a religious institution that was planning to invest in New Era Philanthropy — after performing my own due diligence on behalf of my client, it was clear that it was a Ponzi Scheme. Red flags should not be ignored.

Denial is not just a river that runs through Egypt, it’s also a description of the public company audit quality. An excellent review of AICPA Section 50 on who the real audit clients are! As a Certified Fraud Examiner all too often I see the accountants as having aided and abetted financial statement frauds because they see management as their client, not the shareholders, not the bondholders and not the public, yet they’re the ones being harmed by cooked books. Either audit quality has to improve or shareholders need to start petitioning the SEC to do away with the requirement for annual audits of public companies because auditors have caught exactly ZERO company killing financial statement frauds. Audit fees are way, way too low and we’ve gotten to the point where company boards, their audit committees and management have come to view external audit as a commodity priced mandatory requirement. As a result we have twenty-somethings without enough training, experience or industry expertise conducting the lion’s share of the audit engagements when we really need auditors with thinning hair, gray hair, or no hair on those audits. My vote is for higher audit fees, a wider audit scope with lots more substantive testing by older, wiser auditors. Audit is not a commodity, it’s requires a high degree of skill combined with a hefty portion of professional skepticism to be effective. It’d be nice to see the SEC bar Managers, Senior Managers and Partners for X number of years after a major restatement as a means of punishing auditors. You’d think the Big Four would agree with me that fees, expertise, and the age of the audit staffs are all too low but all they want to do is protect the status quo because they lack the courage and vision to embrace change despite the evidence that the current state of affairs is unsustainable.

Thank you, Francine. Kenny’s enlightenment and wisdom has surely honed your already keen insight . A complete understanding of the internal conundrum faced daily by thousands of good men and women in this industry necessarily requires an appreciation of the underlying “human element and psychology.” Your December 28, 2008 post still stands out above all others in this respect. As MLK once said, “every [person] must decide whether he [or she] will walk in the light of creative altruism or in the darkness of destructive selfishness . . . Our lives begin to end the day we become silent about things that matter.” Perhaps, Kenny’s illumination of the road less traveled was inspired by the words of Buddha “There are only two mistakes one can make along the road to truth; not going all the way, and not starting.”

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Francine McKenna (@retheauditors) is the Transparency Reporter at MarketWatch.com, a Dow Jones publication, where her work is also featured frequently in the Wall Street Journal. McKenna had more than twenty-five years of experience in consulting and professional services including tenure at two Big 4 firms, both in the US and abroad before becoming a journalist. Look for her prior columns, "Accounting Watchdog" at Forbes.com and "Accountable" at American Banker. For more information, click "About" at the bottom of this page. For more information contact Francine McKenna, fmckenna@mckennapartners.com